D&O (abbr., adj.).

D is for...Directors & Officers

D&O (abbr., adj.).

Directors & Officers is a special kind of insurance product designed to protect corporate governors from their own mistakes. When a gang of angry shareholders descends on corporate HQ, waving pitchforks and class-action indictments, it is the D&O insurer which comes to the rescue of Dazed & Outnumbered execs. However, D&O insurance has in the past been structured in such a way that the amount of cover purchased, no matter how great, was insufficient to provide complete indemnity, while the premium paid, no matter how high, was too low to yield an underwriting profit. In answer to this unsustainable situation, cover is now being severely restricted. Record company executives were some of the first to learn this; while insurance for hit singles is still available (at a price), cover for the 'B' side is next to impossible to get.

Flawed implementation
D&O is one of those insurance lines that sounded like a good idea to begin with, but which underwriters got badly wrong in the implementation phase. Nowhere is this more evident than in the so-called US 'laddering' cases, which in essence involved directors and officers of dot.com companies conspiring to manipulate the value of shares, for their own benefit, following an IPO. More than 350 companies have been named in a single class action over the issue, including more than 50 financial institutions which helped bring the dot.coms to market. Some underwriters in Lloyd's of London have predicted the total market loss in this case will reach $2.5bn - a large sum for insurers to pay to cover the enrichment of whippersnapper entrepreneurs egged on by fee-earning investment bankers.

Inherent hazard
Perhaps underwriters should be excused for getting it wrong on D&O... but then, maybe not. After all, even a cursory glance reveals it to be a line with an inherent potential for a high degree of moral hazard. That's what a group of researchers from the University of Oregon thought back in 2001, when they analysed the relationship between D&O insurance buying and share prices. "Is the amount of D&O insurance coverage chosen by managers of IPO firms, and the cost of that insurance, related to post-IPO abnormal stock price performance?" the academics asked. "We hypothesise that the amount of insurance coverage chosen will be related to the post-offering performance of the issuing firm's shares." Lo and behold, an analysis of 72 IPO firms showed "a significant negative relation between the three-year-term stock performance and the amount of insurance purchased at the IPO date."

Insurers have found out the hard way that the more D&O cover you have, the more likely you are to use it. AEGIS, Lloyd's, St Paul, and Royal & SunAlliance learned the lesson when a US judge ruled that as the insurers of the disgraced Enron, they remained Duty-bound & Obligated to advance cash for the defence of the notorious company's tarnished top brass. The insurance industry's response to the costly D&O black hole it has created has been to ratchet rates to new levels. According to the Risk & Insurance Management Society (RIMS), D&O prices were up 83% in the first three months of 2003, after rising 103% in 2002.

Meanwhile, coverage is shrinking, co-insurance has become almost essential to get a programme home, and buyers now need to use more insurers to get the cover they want. AIG, one of the largest US writers of D&O, went as far as suggesting the soft market 'entity cover', which protects companies rather than individuals, be eliminated altogether (later AIG added $700m to its D&O reserves). Many insurers have begun to remove so-called severability clauses, which prevent the wrongful acts of one director from being applied to others. Disputes & Objections have become commonplace, and the US courts are clogged with cases brought by Duped & Outwitted insurers attempting to rescind D&O cover as the loss burden mounts.